On Our Radar

On Our Radar

LKQ Sees Tougher Times Ahead As Growth Slows

Many companies rely on the health of the auto industry for their success, and auto-parts specialist LKQ (NASDAQ: LKQ) has done a good job of taking advantage of the growth in auto sales in recent years. Some have pointed to a potential top in the industry, but coming into Thursday's third-quarter financial report, LKQ investors still expected that the company would be able to produce extremely strong sales growth. LKQ's results weren't quite as good as investors had hoped, and the company sees further pressure persisting throughout the year. Let's look more closely at LKQ's results to see whether long-term shareholders should be worried.

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Image source: LKQ.

LKQ takes its foot off the gas

LKQ's third-quarter results still showed considerable growth, albeit not quite at the pace that some had hoped to see. Revenue soared more than 30% to $2.39 billion, which only looked bad in the context of the consensus forecast among investors for even faster growth of 35%. Similarly, adjusted net income rose 27% to $139.3 million, and that produced adjusted earnings of $0.45 per share. That was good enough to match investor expectations, but it failed to give shareholders the typical earnings beat that they've gotten used to seeing in past quarters.

Some of the trends that investors have seen in past quarters continued during the period. Growth in North America, LKQ's largest segment, was again lackluster, with just 2.3% gains in revenue. By contrast, European revenue soared by more than half, and a combination of acquisitions and organic growth was enough to overcome a double-digit downward impact from adverse foreign exchange movements. The specialty products segment posted about a 10% gain, and the new glass division provided more than a tenth of LKQ's overall revenue. Only the catch-all "other" category showed declines, falling almost 10% in light of organic sales declines.

LKQ also highlighted its recent corporate moves. During the quarter, the company made acquisitions to bolster its exposure to aftermarket products in the Netherlands and Ireland, RV products and accessories in the U.K., and heavy-duty salvage operations in Minnesota. The company's European operations opened three new branches in the U.K. and eight more in Eastern Europe. After the quarter ended, LKQ's Euro Car Parts subsidiary made an asset purchase of U.K. parts distributor Andrew Page, acquiring more than 100 of its branch locations and making further inroads into the European market.

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What's next for LKQ?

CEO Robert Wagman was happy about the way that LKQ performed during the quarter. "The results we achieved in the third quarter reflect the benefits of our increasingly diverse and global operations," Wagman said, adding, "we also continued to realize the benefits associated with the productivity initiatives implemented this year." The CEO noted that "there was softness across parts of the global auto industry" during the period, but he still celebrated the fact that LKQ managed to produce positive growth in organically generated revenue of nearly 4% in the parts and services area.

Unfortunately, not all of that optimism made its way into LKQ's guidance for the immediate future. The company said that it now expects organic revenue growth in parts and services for the full 2016 year to rise at a pace between 4.5% and 5%, and that's well below the 5.5% to 7% range that LKQ had provided previously. The hit to full-year earnings should be more modest, with new guidance of $1.78 to $1.84 per share in adjusted earnings being just a $0.01 to $0.03 per-share reduction from its previous forecast. Nevertheless, slight declines in adjusted net income and cash flow from operations point to current conditions in the industry, as well as currency fluctuations.

LKQ shareholders appeared concerned by the news, sending LKQ shares down 5% by midday following the announcement. The big question that LKQ faces is whether the industry is indeed setting itself up for a downturn. If so, then even the important improvements that the company has made in efficiency and productivity might not be enough to prevent further downward pressure for the business going forward.

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